Has Australia chosen the worst possible time to link its troubled carbon permits scheme to the European Union’s ailing emissions trading system?

Industry, environmental analysts and climate change activists on the continent suggest the answer is yes.

From 2015, the Gillard government will drop its carbon floor price and the value of permits to emit CO2 will be tied to EU levels. This important policy shift leaves a significant pool of government revenue vulnerable to uncertain economic conditions in Europe.

Already Australian economists and environmental activists have expressed alarm about the planned changes to the carbon market regime.

Opposition Leader
Tony Abbott
seized on the announcement as a dangerous attack on national economic sovereignty. “This idea we somehow secure our economic future by tying up with Europe, when Europe is going backwards . . . just shows how wrong-headed this government is."

The Prime Minister, looking for a way out of a politically fraught policy bind, is talking up the historic deal, based on apparently overly-optimistic forecasts of a sharp rise in the price of CO2 from its current $23 a tonne to $29 by 2015-16.

But for more than a year in Europe – in Germany, Austria, Poland, France and beyond – dismay has been growing. The alarm bells have been ringing in business and green political circles, as the much-vaunted Brussels emissions trading scheme baby suffers from the twin pressures of a tumbling carbon price – partly self-inflicted due to confirmed cases of corrupt and illegal trading – and the worsening euro zone and EU-wide debt, economic and political crises.

Political will to tackle climate change issues is also flagging as embattled governments try to tackle mass unemployment and zero or negative growth.

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Former French president
Nicolas Sarkozy
tried and failed to muster sufficient political will for a France-specific carbon tax before his defeat in May. Now Brussels is embroiled in an ideological battle of its own making about whether carbon permit prices should be determined by the market, or manipulated by authorities as a public policy instrument-turned price protection mechanism.

On the eve of the joint announcement by EU Commissioner for Climate Change Action Connie Hedegaard and her Australian counterpart Minister Greg Combet that Canberra and Brussels were linking their emissions trading schemes,Le Monde published a searing analysis entitled “The Carbon Market Under Pressure".

The assessment by the French newspaper of record seemed to back up the view put forward by former Reserve Bank of Australia board member
Warwick McKibbin
that the European scheme was a “failure". European commentators have for the moment steered clear of the potential damage their scheme could inflict on Australia’s collection of billions of dollars of carbon tax.

However, the blowback effect on Australia can be easily deduced from the arguments put forward by Le Monde’s environmental analyst, Grégoire Allix.

Allix says the European market for carbon permits, which has been at the forefront of EU climate policy, is entering into the traditional “rentree" or back to work period following the northern summer break, “under high tension".

The emissions trading system is “blunter than ever" to the point where it plays “only a marginal role" in the reduction of greenhouse gas emissions in the 27 member countries.

“The principle is simple: 11,400 companies are each year taking a reduced number of carbon polluting permits. Businesses that cut back their emissions more can sell their excess permits . . . The problem? The price of a tonne of CO2 has been stagnating for six months between €6 and €8. It must remain between €25 and €30 to convince industry to invest in technologies that are carbon moderate.

“The causes of this plunge in prices are well known: there are too many permits in circulation and not enough CO2 emissions to compensate. Added to the generous allocations of polluting permits are the effects of the economic crisis, which has unleashed since 2009 a mechanical drop in greenhouse gas emissions. The market is drowning in a cumulated excess of 1.4 billion credits . . . the equivalent of almost a nine-month allocation of quotas!"

Earlier this year, before Canberra and Brussels joined forces on carbon pricing, Johannes Teyssen, the director general of the German electricity giant EON, told Switzerland’s Le Temps that the European carbon market was not only “seriously ill". It was “already dead", given a price slump from more than €30 a tonne in 2008 to only €6 or €7 at the beginning of 2012. Le Temps labelled the EU scheme the “European political fiasco".

It said the chaos reigning over the ETS was occurring in a year when Europe was supposed to move into its “third phase" integrating other greenhouse gases into national emissions’ quotas and widening the circle of eligible industries.

If the European market was dead in the opening months of 2012, there has been no Lazarus-like resurrection since.

Commissioner Hedegaard confronted with a Catch-22 situation has been forced to adopt emergency measures over the European summer, walking a tightrope between “demonstrating that there is a pilot in the plane and in the same instance buying time".

She has proposed EU member states “put to the side", according to their choice, 400 million, 900 million or 1.2 billion permits from 2013, and then reintroduce them to the market from 2016 – in other words she wants to reduce supply to support the price.

“It’s not reasonable to continue to flood an already engorged market," she said.

All stakeholders are obliged to comment on this mooted change before the end of October. But the project has already provoked the anger of the industrial sector. From 2013, polluting permits, until now distributed free, will for the large part be put up for auction.

Some member states are already protesting about price manipulation and upsetting the rules of the game. German Economics Minister Philip Rosler, a natural defender of the continental powerhouse of industry and manufacturing, condemned all “artificial swelling of prices" during a visit to Warsaw on August 17. The location of his spray was probably deliberate – Poland, like most new EU members, opposes any moves to rein in CO2 emissions, which could hurt its successful coal industry.

But as Le Monde notes, Poland and Germany are too quick to ignore the reality that the European ETS is more than a simple market, it is “an instrument of public policy". This is where Australia, like it or not, gets caught in problems and priorities light years removed from its own needs.

Still, the position of Brussels’ Climate Change Action Commissioner is extremely fragile considering the stiff resistance she faces from her colleagues in industry and the energy sector. Even hardline environmental advocates and green groups are angry that the EU attempts to intervene to save the European carbon market amid a region in economic crisis simply don’t go far enough.

In July, Austria’s Chamber of Industry and Commerce issued a stern warning deploring the Commission’s direct interventions to shore up the tumbling CO2 price in Europe.

“The CO2 market must remain an instrument of the market. The price of permits must flow from the rules of supply and demand. Under the banner of climate politics, it should not be turned into a game of short term politics," said the Chamber’s Stephan Schwarzer.

The parlous state of the European trading system is at odds with Commissioner Hedegaard’s and Combet’s laudable ideals: to create “the first full international linking of emissions trading systems".

Hedegaard is right that “this would be a significant achievement for both Europe and Australia".

Yet so many negative influences are battering the goal of “establishing a robust international carbon market" experts have been left wondering whether the EU is just treading water until it can stitch up more stringent emissions targets that will automatically revive the emissions trading market.

Hedegaard is said to be desperately seeking a provisional solution to the European carbon market’s near-death throes, in the hope that the situation will improve by 2015. This is when international climate change negotiations are supposed to lead to a new agreement, possible with more drastic measures to combat global warming.

Market analysts, however, do not predict a price rebound before 2019.

“Either the excess permits will be removed [from the market], or stricter targets for reductions in CO2 emissions will be adopted, which will render carbon credits very useful," Le Monde’s Allix says.

In the interim, the Commissioner needs to win time on another front: aviation. All airlines operating in the EU must, from 2013, compensate for a portion of their greenhouse gas emissions by buying carbon credits on the market.

China, India, Russia and the United States refuse to pay for these polluting rights. Under threat from Beijing and facing enormous opposition in the US, the EU is considering exempting the aviation sector from its carbon market, but only if the International Civil Aviation Organisation institutes a global carbon compensation system.

Again, the perverse effect of this exemption could result again in a reduction in demand for permits, and a new weakening of the price of CO2.

That can only be more bad news for Australia’s interlinked carbon pricing regime and its budget bottom line.